LIVINGSTON: Home loan blues and bonds

By Buz Livingston | Just Plain Talk

Published: Thursday, August 15, 2013 at 04:52 PM.

Remember Newton’s Third Law of Motion — every action has an equal and opposite reaction? Proposals curtailing Freddie Mac and Fannie Mae (Federal Home Loan Mortgage Corporation and Federal National Mortgage Association) will have an equal, opposite and perhaps unexpected reaction.

In an area dependent on real estate sales, be mindful of your prayers, they may be answered.

Alone among developed nations, the
United States
offers 30-year, fixed-rate mortgages. U.S. borrowers can choose long-term, fixed-rate mortgages since Freddie and Fannie, not their lender, own most mortgages. By selling mortgages to these government sponsored enterprises (GSE), your local bank does not carry the liability on its balance sheet and can make additional loans.

Passing the loans to Freddie and Fannie increases liquidity and allows for lower interest rates. You may have built it yourself but GSEs subsidize interest rates.

Thirty year mortgages won’t vanish but they will cost more, perhaps substantially more. Bill Gross, the bond guru, warned rates would shoot up three percentage points without GSE involvement.

The Cato Institute’s Mark Calabria believes Gross overstates his case and predicts rates escalating up to one percentage point if government support ends. Calabria referenced jumbo mortgages, covering mortgages $417,000 or higher, which have slightly higher interest rates than conventional Freddie Mac/Fannie Mae loans. Note: Freddie Mac/Fannie Mae limits vary depending on local home prices.

With a 4.25 percent interest rate, the principal and interest payment for a $240,000, 30-year mortgage ($300,000 sale/20 percent down) will be $1,190.06. Bump rates up one percentage point, the principal and interest payment jumps almost $150 ($1,337.91). If Gross is correct, not a huge reach, then multiply three times. Borrowers could also pay additional hidden fees akin to Federal Deposit Insurance Corporation (FDIC) premiums. A Senate bill proposes a Home Mortgage Insurance Corporation much like the FDIC.

Remember Newton’s Third Law of Motion — every action has an equal and opposite reaction? Proposals curtailing Freddie Mac and Fannie Mae (Federal Home Loan Mortgage Corporation and Federal National Mortgage Association) will have an equal, opposite and perhaps unexpected reaction.

In an area dependent on real estate sales, be mindful of your prayers, they may be answered.

Alone among developed nations, the United States offers 30-year, fixed-rate mortgages. U.S. borrowers can choose long-term, fixed-rate mortgages since Freddie and Fannie, not their lender, own most mortgages. By selling mortgages to these government sponsored enterprises (GSE), your local bank does not carry the liability on its balance sheet and can make additional loans.

Passing the loans to Freddie and Fannie increases liquidity and allows for lower interest rates. You may have built it yourself but GSEs subsidize interest rates.

Thirty year mortgages won’t vanish but they will cost more, perhaps substantially more. Bill Gross, the bond guru, warned rates would shoot up three percentage points without GSE involvement.

The Cato Institute’s Mark Calabria believes Gross overstates his case and predicts rates escalating up to one percentage point if government support ends. Calabria referenced jumbo mortgages, covering mortgages $417,000 or higher, which have slightly higher interest rates than conventional Freddie Mac/Fannie Mae loans. Note: Freddie Mac/Fannie Mae limits vary depending on local home prices.

With a 4.25 percent interest rate, the principal and interest payment for a $240,000, 30-year mortgage ($300,000 sale/20 percent down) will be $1,190.06. Bump rates up one percentage point, the principal and interest payment jumps almost $150 ($1,337.91). If Gross is correct, not a huge reach, then multiply three times. Borrowers could also pay additional hidden fees akin to Federal Deposit Insurance Corporation (FDIC) premiums. A Senate bill proposes a Home Mortgage Insurance Corporation much like the FDIC.

South Walton being a notable exception, nationwide home sales fell slightly during June due to rising borrowing costs. Perhaps we don’t need GSEs in the home mortgage game but their absence shifts the paradigm.

What you don’t know about bonds

In the midst of the great July 4th deluge, no one caught the huge bond market decline. On July 5, the 30-year bond lost more than 4 percent or in Dow Jones Industrial Average terms over 600 points. Pundits blame Ben Bernanke but the Federal Reserve directly controls only short term rates. Quantitative Easing, the Federal Reserve’s policy of buying long term bonds, influences but does not directly control longer term rates. Long term rates are set by market forces-buyers and sellers.

Conventional wisdom has the interest rates soaring to the stratosphere when the Fed stops Quantitative Easing and increases short term rates. Raising short term rates in 1995 and 2000 led to a decline in long term rates. Don’t abandon fixed income. The worst five-year period for large U.S. stocks saw a negative 17 percent return. The worst five-year period of five-year bonds was positive 1 percent. For short term needs, consider bonds or bond funds.

Buz Livingston, CFP, has the only investment management and financial planning firm in the entire world headquartered in Blue Mountain Beach. Contact him at 850-267-1068 or www.livingstonfinancial.net.